An automated trading tool gives a user the ability to set up a program that can respond automatically to patterns in market activity, and in response, submit orders directly to an electronic exchange. The use of such trading tools is on the rise and for good reason. Sophisticated trading tools can intelligently sense market conditions and automatically respond often much faster than a human. Until recently, such sophisticated trading tools were available to a limited number of people. Now, in a marketplace where automated programs commonly trade against automated programs, in those circumstances, a manual-style trader may find it difficult to survive without some kind of automated assistance.
Automated trading tools are frequently used to hedge, which is a trading strategy made to reduce the risk of adverse price movements in a tradeable object, by taking an offsetting position in the same or a related tradeable object. For instance, a trader might execute a trade in one market (e.g., the “non-hedging” side), with the intention of quickly offsetting that position in another market (e.g., the “hedging” side). An automated trading tool is what most often performs at least the latter function—offsetting the position by quickly firing an order to the hedging side once the non-hedging order is matched. Hedging also includes taking an offsetting position in the same tradeable object, such that the market represents both the hedging side and the non-hedging side.
A trader might use an automated trading tool in this way to trade a spread, which generally refers to the buying and/or selling of two or more tradeable objects, the purpose of which is to capitalize on changes or movements in the relationships between the tradeable objects. The tradeable objects that are used to complete a spread are each descriptively referred to as a “leg” of the spread. A spread trade could involve buying tradeable objects, buying and selling tradeable objects, selling tradeable objects or some combination thereof. A spread trade might also involve the buying and selling of the same tradeable object—buying the tradeable object at one time and quickly offsetting that position by selling the tradeable object, or vice-versa.
As used herein, the term “tradeable object,” refers simply to anything that can be traded with a quantity and/or price. It includes, but is not limited to, all types of tradeable events, goods, and financial products. For instance, stocks, options, bonds, futures, currency, and warrants, as well as funds, derivatives and collections of the foregoing, and all types of commodities, such as grains, energy, and metals may be considered tradeable objects. A tradeable object may be “real,” such as products that are listed by an exchange for trading, or “synthetic,” such as a combination of real products that is created by the user. A tradeable object could actually be a combination of other tradeable object, such as a class of tradeable objects.
A commercially available trading tool that facilitates the automatic trading of spreads is Autospreader™ from Trading Technologies International, Inc. of Chicago, Ill. Once the legs of the spread are chosen and the relationship between them are defined, a user can input a desired spread price and quantity, and the Autospreader™ will automatically work orders in the legs to achieve the desired spread (or attempt to achieve the spread). The Autospreader™ is currently an add-on tool available with X_TRADER® Pro™, which is a trading application also available from Trading Technologies International, Inc.
U.S. patent application Ser. No. 10/137,979, entitled, “System and Method for Performing Automatic Spread Trading” filed on May 3, 2002 describes one such automated spread trading tool. An example is provided herein to illustrate how an automated spread trading tool like that described in the above application might work. While the example illustrates hedging in a related tradeable object, the same concepts can be similarly applied to hedging in the same tradeable object.
The market information given in FIG. 1 is used to illustrate the following example. In particular, FIG. 1 displays example order book information for two hypothetical tradeable objects, referenced in the figure as product “1” and product “2.” Each of the tradeable objects may be offered by one electronic exchange or separate electronic exchanges, it does not matter. The working orders column (“Wrk Ord”) is shown in the far left columns, bid quantity is shown in the left columns (“Bid Qty”), the corresponding price—or some symbolic representation thereof—is shown in the center columns (“Price”), and the ask quantity is shown in the right columns for each tradeable object (“Ask Qty”). While presenting the order book information in this manner makes it easier to illustrate the following example, the actual layout of the order book information does not matter for this example.
The inside market for each tradeable object includes the best bid price (or sometimes referred to as the “highest bid”) and the best ask price (or sometimes referred to as the “lowest ask”). The best bid price represents the highest price any buyer is willing to pay for a given tradeable object at a given time, and the best ask price represents the lowest price any seller is willing to sell a given tradeable object at a given time. The quantity available at the inside market and at other price levels is referred to as market depth. Referring to FIG. 1, at a current moment in time, the inside market for product “1” is bid at “295” and ask at “297.” The quantity available for product “1” at the inside market is “165” at the bid and “210” at the ask. The inside market for product “2” is bid at “440” and ask at “442.” The quantity available for product “2” at the inside market is “230” at the bid and “150” at the ask. Other bid and ask quantities at various price levels are also shown.
To begin, a trader will typically input certain parameters that the trader wishes to achieve by the spread trading tool, such as what tradeable objects to trade, what tradeable objects to quote, and a desired spread price. As an example, let us assume that the trader wishes to quote product “1” and hedge in product “2,” and for purposes of description, the trader wishes to sell the spread, which refers to selling product “1” and buying product “2.” Using this information, the automated spread trading tool will first automatically work a sell order (or multiple sell orders) for product “1.” The price of the sell order is typically based on the desired spread price and the current best ask price of product “2” (the current best ask price is the lowest price for which product “2” can be bought). FIG. 1 shows that the spread trading tool has automatically entered an order to sell “120” at a price of “297,” (“S 120”). When the sell order fills, then a corresponding hedge order is automatically sent to buy “120” (or some other designated amount) of product “2,” at market to complete the spread. In other words, the spread trading tool is programmed to “fire off” a hedge order when one of the non-hedging orders is filled. The spread price actually achieved is based on the selling price of product “1” and the buying price of product “2.” While the desired spread price is the price to aim for, the spread price actually achieved by selling product “1” and buying product “2” might be different from the desired spread price.
In some instances, however, during the time it takes to react to the order in product “1” getting filled, the market conditions of product “2” may move in an undesirable way. For instance, according to this example, if the inside market for product “2” moved up in value just before the hedge order was added to the order book at the exchange, then the order would miss the market (e.g., the best ask would now be higher than what was previously thought). Now, referring to FIG. 2 to illustrate this further, assume that the order to sell in product “1” was filled, and the automated trading tool fired off a hedge order to buy product “2.” However, assume that the lowest ask price just moved up in price and the hedge order missed the market. Then, in an effort to complete the spread the trader will have to pay more (in this instance) than what he originally expected by moving his buy order to “443.”—now, he will have to pay “443,” which translates to one price higher for each of “120.”
To avoid situations like this, a trader might notice the market moving in a direction before the above scenario actually occurs. In the instant example, it makes more sense to buy product “2” first, then hedge in product “1” with a sell order. That way, the trader would buy product “2” at a lower price (before it moved) and then offset that order by selling product “1.” Assuming the trader can actively quote both legs, the trader might quickly—if not already too late, which is mostly the case—enter an order to buy product “2” with the hopes of catching the “wave.” Then, if the order to buy product “2” is matched, the spread trading tool would automatically hedge in product “1.” Unfortunately, the trader, in most circumstances, is not given the opportunity to delete all of his orders to sell product “1” leaving him with an open position. If he took the time to delete the orders and execute this new strategy, then he may have missed out on the opportunity.
As automated trading tools become the norm in electronic trading, it is increasingly important to develop more intelligent tools to assist the trader in making the most desirable trades.